Five criteria to tick for quality investments

Investors have good reason to be confused after a week that saw the seeds of a bearish rout in technology stocks, a bullish $2.1 billion bid for
David Jones
, a shock profit warning from a market darling
Coca-Cola Amatil
and a confidence building $400 million capital raising on the back of strong interim results from
Bank of Queensland
.

Boil down those two big negatives and two big positives and you have a strong argument in favour of looking at less conventional ways of generating excess returns in Australian equities.

The vanilla approach of buying shares and holding for the long term remains as a valid strategy. But the attractions of achieving absolute returns through long-short strategies should not be ignored.

The list of benefits from having exposure to a long-short fund include greater flexibility when markets move, the ability to hedge risks, lower volatility of returns and being able to bet against management with a poor track record.

Stocks in the technology, media and telecommunications (TMT) sector are under pressure for good reason. They have become expensive using a range of valuation measures.

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This is especially the case in the United States where investors are sniffing the sort of tech crash that occurred in 2000. In Australia, the declines in TMT stocks is understandable.

Poster child businesses such as SEEK, REA Group and Carsales.com have run hard for several years and now have forward price earnings multiples more than double the value placed on the S&P ASX200.

Easily the most highly rated technology stock on the ASX is accounting software company
Xero
. It has fallen 32 per cent since March 20 but still trades at 61 times its estimated annual revenue.

Xero loses money and is up against powerful competitors around the world including Intuit in the US and MYOB in Australia. MYOB invests as much in technology development each year as Xero loses.

The David Jones takeover by South African retailer
Woolworths
at $4 a share totally blew away local fund manager perceptions of the Australian department store market. Woolworths, led by chief executive
Ian Moir
, is investing for the long term in a market that many believe is in serious structural decline. One fund manager told Chanticleer that the South Africans were “mad" to pay so much for a business which has such a poor outlook.

However, almost half of the David Jones balance sheet is comprised of prime central business district property that is keenly sought after by international retailers.

The lesson from the David Jones sale is that companies that miss big structural changes such as online shopping are more likely to lose their independence.

In fact, it is worth remembering five useful hurdles for choosing a quality equity investment: management quality, key competitive advantages, no structural deficiencies, low risk of impairment and good continuity of earnings.

A company that has ticked all these boxes is
Bank of Queensland
. Since new management took over in late 2011 the stock has doubled in price. It delivered a record half year result on Friday although one analyst said he was disappointed in the composition of the result.

However, on Friday, there was strong support for a $400 million capital raising because of the solid growth outlook and strong capital position. Much of the growth will come from Brendan White’s business banking division which has been expanded with the $440 million purchase of the Investec professional finance business, asset finance and leasing business.

While Bank of Queensland ticked the five criteria for quality, Coca-Cola Amatil did not. It has structural deficiencies and there are doubts about the continuity of earnings because of the pressure from Coles and Woolworths. However, Coca-Cola Amatil, which has a new chief executive in
Alison Watkins
, retains ownership of fridges in just about every corner store in Australia. That is about half its business and it is a powerful profit engine.

The fresh way of looking at investing with the objective of achieving absolute returns is to examine the range of long-short equity funds offered by a range of managers including Antares Capital, BlackRock, Acadian Asset Management, Watermark Funds Management, Aurora Funds Management, Optimal Funds Management, Regal Funds Management and Merricks Capital.